Conventional Loans

WHAT ARE CONVENTIONAL LOANS?

Conventional mortgages or conventional loans are loans for homebuyers that aren’t offered or guaranteed by government entities. You can obtain Conventional mortgages through private lenders such as banks and credit unions.

Conventional loans are mortgage loans that the government does not back. Conforming and non-conforming loans as well can be broken down into traditional loans.

Conforming conventional loans is subject to the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). Some lenders might offer some flexibility for non-conforming conventional loans.

Conventional loans are more popular than government-backed financing and were the most popular option for home financing in the first quarter of 2018. Borrowers used them to finance 74% of all new homes sold.

Conventional loans have high flexibility, but they can also be riskier since the federal government doesn’t insure them, making it more challenging to get a traditional loan.

You can follow various guidelines to qualify for conventional loans since Conventional Loans do not have specific requirements. However, Conventional Loans generally have more stringent credit requirements than FHA loans or government-backed loans. You will require a minimum credit score of 620 and a 50% or less debt-to-income ratio.

Conventional loans are sometimes mistakenly termed as conforming loans or mortgages. Although there are some overlaps, they are two distinct types. Conforming mortgages are those whose terms and conditions satisfy the funding criteria of Fannie Mae or Freddie Mac. The Federal Housing Finance Agency (FHFA) is tasked with setting the annual dollar limit; for example, in 2021, a loan cannot exceed $548,250 in the United States.

All conforming loans are considered conventional. However, not all conventional loans can be classified as conforming. For example, a $500,000.00 jumbo mortgage is a conventional mortgage but not a conforming one because it exceeds the amount that Fannie Mae and Freddie Mac would back.

There were around 8.3 million homeowners who had FHA-insured loans in 2020. The secondary market is large and very liquid for conventional mortgages. Conventional mortgages are packaged in pass-through mortgage-backed security, which trades in an established forward market called the mortgage To Be Announced (TBA). Many of these traditional pass-through securities can be further securitized as collateralized mortgage obligations.

WHAT IS THE PROCESS OF CONVENTIONAL LOANS?

Conventional mortgages usually have a fixed interest rate, which means that the interest rate is constant throughout the loan’s life. The federal government does not guarantee conventional loans or mortgages, and banks and creditors have to meet stricter lending criteria for conventional mortgages.

The Federal Housing Administration (FHA), U.S. Department of Veterans Affairs, and USDA Rural Housing Service can secure mortgages for banks. Borrowers must satisfy specific requirements to be eligible for these programs.

Private mortgage lenders, such as banks, credit unions, and other financial institutions, originate and service conventional loans. Many of these institutions also offer government-insured loans. Conventional loans generally don’t provide the same benefits as government-insured loans. They have lower credit scores requirements, no down payment, and do not require mortgage insurance.

A conforming conventional loan can be approved with credit scores as low as 620. However, some lenders will require a credit score of at least 660. Your credit score and credit history will play a significant role in determining your interest rate.

Your credit score and overall credit history will determine how much interest you pay over the life of your loan. Conventional mortgage loans can be obtained with as little as a 3% down payment, while some lenders offer 100% financing. If you do not put down 20% or more, lenders will typically require you to pay private mortgage insurance, which can be between 0.3% and 1.5% annually.

Conventional loans are typically for 30 years but, it is also possible to get a conventional mortgage loan for 15 or 20 years.

Lenders have tightened their requirements for loans in the years following the 2007 subprime mortgage meltdown. “No verification” and “no deposit” mortgages have been widespread, but the core requirements have not changed. Potential borrowers must complete an official mortgage application and pay an application fee. The lender will then require the documents necessary to conduct a thorough credit check, review their credit history, credit score, and background.

TYPES OF CONVENTIONAL LOANS:

1. Conventional Conforming Loans: Conforming conventional loans are loans that conform to the requirements of Fannie Mae or Freddie Mac. They can be up to maximum loan amounts. 2019’s standard limit for a conforming conventional loan is 4 350 for a single-family home you plan to live in. The limit for borrowers who live in high-cost locations can reach $726,525.
2. Jumbo Conventional Loans: You should seek lenders specializing in jumbo mortgage loans if you need to borrow more money than what is allowed for conforming loans. Jumbo loans require higher credit scores (think 700+) than conforming loans. You may also need a lower debt to income ratio (DTI) and higher down payment. Even with these things, you might end up paying a higher interest rate for a conforming loan than a conventional loan because the lender has a greater risk with larger loans.
3. Portfolio Loans: Portfolio loans are conventional loans that a lender decides to keep in its portfolio instead of selling them on the common secondary market, but it requires that loans meet Fannie Mac and Freddie Mac standards. Portfolio loans allow lenders greater flexibility in underwriting, which can benefit those with low credit scores or high DTI. Portfolio loans are more expensive and do not offer the same consumer protections as conforming loans.
4. Conventional Subprime Loans: For conforming loans, you must have a lower debt-to-income ratio of less than 50% and a credit score greater than 620. If your credit score isn’t perfect, you might be eligible for a subprime loan. These loans can be non-conforming and may have high interest rates and closing costs. These loans can be a great way to get into a house without having to wait for your credit to improve.
5. Conventional loans that are amortized: These loans are fully amortized. Homebuyers receive a fixed monthly payment starting at the beginning and end of the loan repayment period. Fixed or adjustable mortgage rates can be available for conventional loans that are being amortized.
6. Conventional Adjustable Loans: Fixed-rate mortgage loans have the same interest rate and, therefore, the same monthly payments throughout the loan’s life. An adjustable-rate mortgage loan will have a fixed interest rate that you can pay for a specified period, usually between 3 and 10 years. The lender will adjust your interest rate each year according to current market rates. Although adjustable conventional loans have lower interest rates than fixed conventional loans, their overall cost can rise if market rates rise.

 

DIFFERENCE BETWEEN CONVENTIONAL LOANS, FHA, GOVERNMENT-BACKED LOANS, USDA LOANS:

Individual homebuyers may find government-insured mortgage loans a good choice because of their unique features. Let’s take a review of each option and who might be interested in it.

• FHA loans: These loans let you get into a house with as little as 500 credit or as high as 580 credit if there is a 3.5% down payment. If your credit score isn’t good enough to be eligible for a conventional loan, this may be an option. FHA loans are backed by the Federal Housing Administration and allow you to be approved with as little as 580 credit score. Conventional loans have a smaller down payment (3%), but you will need a credit score of at minimum 620 to be eligible.

It is crucial to calculate the cost of mortgage insurance when deciding between an FHA loan or a conventional loan. You will have to pay premium mortgage insurance if you pay less than a 10% down payment on an FHA loan, which applies regardless of how much equity your home has. You would not be required to pay private mortgage insurance for a conventional loan if you have 20% equity.

• VA loans: These are the loans backed by the U.S. Department of Veterans Affairs (USDVA) for selected members of the military community and their spouses and other beneficiaries. VA loans have the exact requirements as conventional loans. However, VA loans offer a few additional benefits. Firstly, VA loans do not require a down payment, and secondly, VA loans do not require you to have mortgage insurance.
• USDA loans: These loans are insured by the U.S. Department of Agriculture and can be used to help homebuyers with low- or moderate incomes who wish to buy a home in a rural area. These loans do not require a down payment and offer more flexibility in terms of credit score requirements. Conventional loans do not have a maximum income, but USDA loans have income limitations depending on where you live and the state in which you are buying your home. Your lender will assess your eligibility for a USDA loan, including the incomes of all family members who are part of the household, not just those who are borrowers.

USDA loans do not require that borrowers pay PMI, but they require that borrowers pay a guarantee fee similar to PMI. The fee is 1% of your total loan amount if you pay it upfront. The guarantee fee can also be paid as part of your monthly payments, generally less expensive than PMI.

INTEREST RATES FOR CONVENTIONAL LOANS:

Conventional loans interest rates are generally higher than FHA loans. However, these loans require borrowers to pay mortgage insurance premiums.

A conventional mortgage’s interest rate depends on many factors. These include the term of the loan, its length, size, whether it has an adjustable or fixed interest, as well as current economic and financial market conditions.

The future inflation expectations of mortgage lenders are used to determine the interest rates. The demand and supply of mortgage-backed securities will also influence the rates.

The Federal Reserve increases the cost of borrowing by aiming for a higher federal funds interest. Banks then pass these higher costs on to their customers. Consumer loan rates, including mortgage rates, also tend to rise.

Points or fees paid to the broker (or lender) are usually linked to the interest rates. The higher the points you pay, then the lower your interest. A point is a fee that costs 1% of the loan amount. It reduces your interest rate by approximately 0.25%.

The last factor determining the interest rate is the borrower’s financial situation: their assets, creditworthiness, and the amount of down payment they can make on the financed property.

If a borrower plans to reside in a home for more than ten years, they should consider purchasing points to lower interest rates for the loan’s life.

PRIVATE MORTGAGE INSURANCE:

Private mortgage insurance (PMI) will be required if you deposit less than a 20% down payment for a conventional loan. PMI protects your lender if you default on your loan. PMI costs vary depending on the type of loan, credit score, and down payment.

The PMI is typically paid with your monthly mortgage payment. However, there are other options. Some buyers pay it with a slightly higher interest rate, while others pay it upfront. It is easy to determine which payment option is most affordable for you when choosing PMI.

PMI doesn’t stay on your loan forever. That is because you do not need to refinance to get rid of it. You can request that your lender eliminate the PMI from your mortgage payments once you have reached 20% equity. Your lender can request a new appraisal of your home‘s value when you have attained 20% equity, which will allow them to calculate your PMI requirements. Your lender will remove PMI automatically from your loan once you have reached 22% equity.

THE PROS AND CONS OF CONVENTIONAL LOANS:

Conventional loans are very popular because of the flexible features:

1. Low-interest rates
2. Quick loan processing
3. There are many options for down payments, starting at 3% of the sale price.
4. There are many term lengths available for a fixed-rate mortgage. They can be from 10 to 30 years.
5. Private mortgage insurance (PMI) at a reduced rate

Conventional loans are flexible, but you still have to make decisions after choosing this type of loan. It is important to decide how much money you are willing to put down, how long your loan term will be and how expensive a house you can afford.

Cons of Conventional loans:

1. Higher Credit Score Requirements: The minimum credit score requirement for a conventional loan is 620. You can obtain an FHA loan with credit scores as low as 500. USDA loans require a minimum credit score of 580.
2. Higher down payment requirements: The minimum down payment requirement is 3%, slightly lower than FHA loans requiring a minimum 3.5% down payment. A higher down payment is necessary to get a lower interest rate or avoid private mortgage insurance.
3. Stricter Qualification Guidelines: Mortgage loans that the government ensures have less risk to the lender. Based on your circumstances, it may be easier for you to get one if you meet the eligibility requirements than getting a conventional loan. On the other hand, a conventional loan may require you to review your financial situation more carefully as the lender takes on greater risk in starting the loan.

ELIGIBILITY FOR CONVENTIONAL LOANS:

No lender can fully finance all properties and will review your assets and liabilities to determine if you can afford the monthly mortgage payments (not exceeding 28% of your income).

Eligibility criteria:

1. Evidence of income: These documents may include, but not be limited to, thirty days’ worth of pay stubs showing income and year-to-date earnings, two years of federal tax returns, sixty days or a quarterly report of all assets accounts, including savings and checking accounts, two years of W-2 statements Additionally, borrowers must be prepared to show proof of additional income such as alimony and bonuses.
2. Assets: Bank statements and statements from investment accounts will be required to prove you have the funds to pay the residence’s down payment and relative costs. Gift letters are required if you receive money from a relative or friend to help with the down payment. These letters will certify that they are not loans and do not require repayment, and the letters may also need to be notarized.
3. Employment verification: Today’s lenders want to ensure that they only lend to borrowers with a steady work history. Lenders will request your pay stubs, and they may also contact your employer to confirm that you are still working and check your salary. A lender might contact your former employer if you have recently switched jobs. For self-employed borrowers, you will need to submit additional documentation about your business and income.
4. Additional Documentation: To pull your credit report, your lender will need to see your driver’s license or state ID card.

Factors that might cause ineligibility:

In general, people who are just starting in their lives, have a bit more debt than usual or have a low credit score often have difficulty qualifying for conventional loans. These mortgages are difficult for people who have:

1. been in bankruptcy or foreclosed on during the last seven years,
2. credit scores below 650,
3. DTIs higher than 43%, or
4. a down payment of less than 20%, or even 10%, of the home’s purchase price, which is unacceptable.

If you are denied a mortgage, make sure to get the reasons in writing. There may be other programs that you qualify for that will help you get approved for a mortgage.

FHA loans may be available if you don’t have a good credit record and are a first-time homeowner. FHA loans are loans specifically designed for first-time homebuyers and have different credit requirements.

SOME TIPS TO HELP YOU GET A CONVENTIONAL LOAN:

1. Keep a check on your Credit Score: Before applying for any loan, it is essential to understand where you stand in terms of credit. A conforming conventional loan will be approved if your credit score is at least 620. Your credit score should be in the middle-to-upper 700s to increase your chances of getting approved for a conforming conventional loan.
2. Improve your Credit Scores: This means paying your bills on time (and not getting behind on late payments or collections accounts), paying down your credit card debt, and avoiding unnecessary borrowing. To help you scrutinize the areas that require special attention, request a free copy of your credit report. While improving your credit may take some time, it could save you thousands of dollars over the life of a loan. You will be able to get a conventional loan even if you have ever been in bankruptcy. You will be eligible for a traditional mortgage two years after you have completed a Chapter 13 repayment program. Four years is the waiting period for a Chapter 7 bankruptcy.
3. Preapproval Letter: A mortgage lender will send you a letter confirming that they are willing to lend you money to purchase a home. Although it is not a mortgage application, it will require documentation about your financial situation, including tax returns, payslips, statements from investment accounts, and bank statements. It also contains a credit check. Preapproval letters can help allow you to make an offer on the house that you like. Preapproval letters typically last between 60 and 90 days, so you have plenty of time to find a home. Before approving your mortgage application, the lender will check your credit score and financial standing again.
4. Save up for a down payment: Although conventional loans do not usually require large down payments, you will have better chances of getting a lower interest rate if you have more down payment money. Some lenders will require as little as a 3% down payment, while others may offer 100% financing. If you can manage it, save enough money to pay 20% or more for private mortgage insurance.
5. Check Your Debt-to-Income Ratio: While credit scores are one factor that will determine your eligibility for conventional mortgages, lenders will also consider your debt-to-income ratio. Lenders want to see that your total monthly debts are less than 36%. If you have very good credit, high savings, or pay a minimum of 20% down payment, lenders may increase your DTI requirement to 43%. Conforming loans are allowed by Fannie Mae or Freddie Mac up to 50%.
6. Commit to putting at least 10% down: You can avoid PMI by making a 20% down payment. A larger down payment helps reduce your monthly payments and gives you equity in your home.
7. Stay with a fixed-rate mortgage for 15 years: Why choose a 15-year term? A 15-year term will result in higher monthly payments, but interest rates will be lower than a 30-year mortgage. Fixed rates are more secure than variable rates. It is fixed for the term of the loan.
8. Your mortgage payment should not exceed 25% of your monthly take-home pay: This is our last piece of advice and the final step. You can save money for retirement and college when you own a house that you can afford.

Contact Todd Uzzell, our Mortgage Loan Officer, today via our website! Get the personalized, detailed, and comprehensive Mortgage advice you need. Our company is dedicated to helping clients achieve their goals. We can help you with refinancing or buying a house.